Reinhart and Rogoff Were Right About New Zealand

(Originally published here.)

Before Peter Jackson chose to film the “Lord of the Rings” and “Hobbit” films in his native land, New Zealand was mostly known as the small country next to Australia. Its main exports are milk and meat from pasture-raised sheep, cows and deer.

This hasn’t prevented a few pastoral islands from playing an outsized role in the controversy surrounding Carmen Reinhart’s and Kenneth Rogoff’s research into the connection between government indebtedness and economic growth.

To briefly recap for the five people who may not have heard, in 2010, Reinhart and Rogoff wrote a short paper called “Growth in a Time of Debt.” It was often cited by deficit doomsayers who favored tax increases and spending cuts, even though the findings didn’t actually support those policies.

Then, about two weeks ago, Thomas Herndon, Michael Ash and Robert Pollin, economists at the University of Massachusetts Amherst, released a paper of their own. (Like “Growth in a Time of Debt,” it hasn’t been peer-reviewed.)

After attempting to replicate Reinhart’s and Rogoff’s original results, they claimed to have found calculation errors, questionable methodology and omitted data that undermined the thesis that debt above 90 percent is historically associated with lower growth. (Reinhart and Rogoff have acknowledged the calculation error in their spreadsheet but disagree with their critics about methodological shortcomings.)

Herndon, Ash, and Pollin believe that the biggest problem is the absence of data from New Zealand during the postwar period:

“The exclusions for New Zealand are of particular significance. This is because all four of the excluded years were in the highest, 90 percent and above, public debt/GDP category. Real GDP growth rates in those years [1946-1950] were 7.7, 11.9, -9.9, and 10.8 percent. After the exclusion of these years, New Zealand contributes only one year to the highest public debt/GDP category, 1951, with a real GDP growth rate of -7.6 percent. The exclusion of the missing years is alone responsible for a reduction of -0.3 percentage points of estimated real GDP growth in the highest public debt/GDP category. Further, RR’s unconventional weighting method that we describe below amplifies the effect of the exclusion of years for New Zealand so that it has a very large effect on the RR results.”

That sounds pretty damning but it turns out that on the New Zealand question, at least, it’s Reinhart and Rogoff who are right, and Herndon, Ash and Pollin are wrong.

National income accounting is an old concept, though modern measurements of gross domestic product didn’t exist until the 1930s. And many countries — including rural New Zealand — didn’t start counting their national income until much later. The data we have has been reconstructed by economists using forensic techniques.

Unfortunately, when it comes to New Zealand, we are now finding out that the numbers many economists have used are just wrong. In this case, the culprit is none other than the celebrated Maddison Project, which Nobel laureate and New York Times columnist Paul Krugman endorsed as an essential data source just this past weekend. He is no fan of Reinhart’s and Rogoff’s work.

Historians of New Zealand know that there was a boom in 1951 as a result of the U.S. Army’s demand for wool to make uniforms during the Korean War. According to Statistics New Zealand, the real economy expanded by about 16 percent in just that one year. Output contracted in the following years as the demand for wool subsided.

The Maddison database, however, implies that the economy contracted sharply in 1951 after a boom in 1950 — that’s backwards. The supposedly crucial “missing years” also look a lot less impressive when properly counted. According to Statistics New Zealand, the economy grew by 3.0 percent in 1946, 0.4 percent in 1947, and 3.2 percent in 1948. New Zealand’s GDP shrunk by 5 percent in 1949 and then grew by 5 percent in 1950.

Carmen Reinhart posted a brief note on her website explaining as much, adding that she has notified the curators of the Maddison data of the error. However, when I checked the database earlier today, the mistake hadn’t been fixed.

When Reinhart and Rogoff wrote their original paper in 2010 they used the glitchy data from Maddison. Herndon, Ash, and Pollin used those incorrect numbers in their replication of Reinhart’s and Rogoff’s work. Their critique, which was so reliant on the data from New Zealand, therefore misses the mark.

Last summer, Reinhart and Rogoff, along with Vincent Reinhart, published a formal presentation of their updated research in the Journal of Economic Perspectives. That paper used corrected data, which is one reason why they felt comfortable including New Zealand’s economic performance from the second half of the 1940s in their calculations. The formal paper also used a methodology similar to the one that Herndon, Ash and Pollin said they would have preferred.

So does the clearing up of the New Zealand contretemps end the broader controversy? Far from it. According to the 2012 paper by Reinhart, Reinhart and Rogoff, government “debt/GDP levels above 90 percent are associated with an average annual growth rate 1.2 percent lower than in periods with debt below 90 percent debt.” More substantively, they write that “the relationship cannot be entirely from low growth to high debt” and that “very high debt likely does weigh on growth.”

The recent critique of “Growth in a Time of Debt” held that the 2010 paper was riddled with data errors. That critique, however, is also based on errors that are just as devastating to its case.

Personally, I blame the sheep.

(Matthew C. Klein is a contributor to the Ticker. Follow him on Twitter.)


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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